The 2017 Tax Cuts and Jobs Act created substantial benefits for taxpayers who realize gain and timely invest such gain into a “qualified opportunity fund” or “QOF.” A QOF is a partnership or corporation which is organized for the purpose of investing in a qualified opportunity zone. Qualified opportunity zones are certain census tracts throughout the country that have been designated as such by the Secretary of the Treasury.
Below are the top 10 things that you should know about opportunity zones.
- Opportunity Zones are everywhere. A map of all qualified opportunity zones can be found here. Click on the “Layers” tab on the menu on the right hand side of the screen. Select “Opportunity Zone Tract” and unselect “2011-2015 LIC Census Tract,” and zoom in to a specific area on the map. Designated qualified opportunity zones will appear in blue.
- Realize gain now; pay tax in 2026 at a 15% discount. Investing in opportunity zones provides two groups of benefits. The first group of benefits relates to the treatment of a gain that has been invested into a QOF. A taxpayer can trigger gain (g. by selling stock) currently, but not pay tax on the gain until 2026, as long as the entire gain (not the entire amount realized) is re-invested into a QOF. In addition, when the taxpayer pays the tax on the deferred gain in 2026, up to 15% of the deferred gain can permanently escape taxation. Given that only the amount of the gain needs to be re-invested, investing in a QOF allows taxpayers to access cash that may not otherwise have been accessible without immediate tax costs. To illustrate, if a taxpayer owned stock with a cost basis of $75 and a fair market value of $200, the taxpayer could sell the stock and access the $75 of cash with no immediate tax cost as long as $125 of the proceeds are re-invested into a QOF.
- Hold the interest in the Qualified Opportunity Fund for 10 years and pay no tax on the appreciation. The second group of benefits relates to the appreciation of the investment in the QOF itself. If the taxpayer holds the interest in the QOF for at least 10 years, any gain realized upon the sale of the QOF interest can be tax free.
- Gain eligible for deferral must be realized upon a sale or exchange with an unrelated party. In order to qualify for the opportunity zone benefits, the re-invested gain must not arise from a sale or exchange with a “related person.” Complicated attribution rules apply to determine whether two parties are related.
- Deferral elections can be made by a pass-through entity or its owners / beneficiaries. If a partnership realizes gain, the partnership itself could make an opportunity zone deferral election and the gain would not be included in the partners’ distributive share. Alternatively, if the partnership does not make the deferral election, the individual partners may make the election. Analogous rules apply to S corporations, estates, and trusts.
- Invest in a QOF before the end of 2019 for maximum benefit. In order to achieve the maximum 15% tax reduction on deferred gain, an investment in a QOF must be made before the end of 2019. This is a function of the incremental benefits provided by the law. The statute requires that deferred gain will be recognized (and taxable) on December 31, 2026 at the latest. If the taxpayer holds the QOF for at least 5 years prior to December 31, 2026, a 10% discount on the tax owed on the deferred gain is available. However, if the taxpayer has held the interest in the QOF for at least 7 years (at least since December 31, 2019), then the taxpayer will receive the full 15% discount.
- Investment in QOF must be made within 180 days of triggering the gain. It is critical that a taxpayer seeking opportunity zone benefits make an investment into a QOF within 180 days of the event triggering the gain. Special timing rules apply to partnerships. For example, if a partnership uses the calendar year as its tax year, the 180 day time period can start at the end of the partnership’s tax year rather than the day in which the partnership itself realized the gain.
- 90% of the QOF’s assets must be located within an opportunity zone, but with proper structuring the overall percentage of assets within the zone could be as low as 63%. A QOF must directly have 90% of its assets within a qualified opportunity zone. The QOF performs the test twice a year and a penalty can apply to the QOF if it does not meet the test. However, if the QOF invests indirectly (through a subsidiary) in a qualified opportunity zone, then as little as 63% of the structure’s overall assets need to be within the qualified opportunity zone.
- Generally assets acquired prior to January 1, 2018 are deemed to be outside a qualified opportunity zone. In order to satisfy the asset testing requirements, an asset generally needs to be acquired from an unrelated party by purchase after December 31, 2017. However, there are strategies for owners of pre-existing assets located within a qualified opportunity zone to receive investments from QOFs.
- There are no monetary limitations for opportunity zone benefits. An unlimited amount of gain could potentially be deferred until 2026, and an unlimited amount of appreciation of the QOF itself can escape taxation.